Bond Markets Are Embracing Social and Environmental Impact

Tapping into a growing sustainable investor base is just one of the advantages that companies might reap from issuing green, social and sustainability bonds.

Two years ago, few investors would have predicted that a social initiative, such as supporting ethical farming or gender equality in the workplace, could be financed via a bond. Today companies are looking beyond environmental impact to advance broader sustainability strategies through bond issues. They’re using them to send important signals to investors, according to the Morgan Stanley Institute for Sustainable Investing’s latest report, “Sustainable Value: Sustainable Bond Issuance as an Investor Signal."

Sustainable bonds can be a valuable tool for issuers to communicate their priorities to investors.

“In 2017, green bond issuance came in at $163 billion.1 With such strong momentum in the market, we expect to see even more interest in financing all facets of sustainability this year,” says Navindu Katugampola, Head of Green, Social and Sustainability Bonds at Morgan Stanley.

While green bond proceeds are tied to environmental projects, social and sustainability bonds can be used to finance specific social causes and/or a mix of social and environmental initiatives. The groundswell in sustainable investing has certainly fueled the rate at which companies are jumping on green and social bonds, but it isn’t the only reason. Companies can use them to showcase their ESG strategies to institutional and retail investors alike.

“Sustainable bonds offer more than just access to capital,” says Hilary Irby, Co-Head of Global Sustainable Finance at Morgan Stanley. “They can be a valuable tool for issuers to communicate their priorities to investors. Bonds can send important signals to the market about sustainability strategies; demonstrate proactive risk management, and long-term thinking, while offering a financing and communications tool that is tied to measurable results.”

To provide a holistic approach, Morgan Stanley established its Global Sustainability Bond Leadership Council in 2017 to oversee and coordinate the development of the firm’s green, social and sustainability bond franchise. The Council guides firm strategy for client solutions, investor engagement and thought leadership in this rapidly changing market.

Shifting Demand

Sustainable investing has been increasing for some years, but global developments, such as the signing of the Paris Accord in 2015, have catalyzed much broader interest among investors about the benefits that a strong ESG policy can have on a long-term investment. Consumer preferences are shifting toward companies that produce sustainable products, or ensure that their business activities are responsible. Among U.S. consumers, 87% will buy products based on their values and 76% want companies to address climate change.2 “By issuing a sustainable bond,” notes Irby, “a company can broadcast to the market that they are cognizant of changing trends in the market place, and that they are preparing for a more sustainable future.”

Keeping up with new regulations is one reason why two gender-equality bonds were issued in 2017 by separate Australian financial institutions. To signal their support of gender diversity to the Australian government’s Workplace Gender Equality Agency, the National Australia Bank issued an A$500 million gender equality bond3 in March, 2017; the proceeds were lent to Australian companies that actively foster gender equality. In November, Australian insurer QBE followed with the first U.S.-dollar-denominated gender equality social bond by a private sector entity.4 QBE will use the US$400 million in proceeds to buy bonds in companies that have signed onto the United Nations’ Women’s Empowerment Principles.

A Wider Investor Audience

The broader investor base is sitting up and taking notice of sustainability, considering ESG factors to help manage risk and create new value. Asset managers have been among the loudest voices. In January 2018, BlackRock’s CEO issued an open letter5 calling on companies and investors to consider the role they can play to advance positive social outcomes. PIMCO, another global asset management firm, is encouraging issuers to tie financing to the UN Sustainable Development Goals (SDGs),6 which address a broad swath of environmental and social challenges.

Katugampola sees the SDGs as a major force driving new sustainability bond issuance. “They have become a framework through which companies and investors alike can make sense of the world’s most pressing challenges. Their breadth makes them ripe for sustainability bonds that couple social and environmental impact.”

This material was published on April, 2018 and has been prepared for informational purposes only and is not a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. This material was not prepared by the Morgan Stanley Research Department and is not a Research Report as defined under FINRA regulations. This material does not provide individually tailored investment advice. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. Morgan Stanley Smith Barney LLC and Morgan Stanley & Co. LLC (collectively, "Morgan Stanley"), Members SIPC, recommend that recipients should determine, in consultation with their own investment, legal, tax, regulatory and accounting advisors, the economic risks and merits, as well as the legal, tax, regulatory and accounting characteristics and consequences, of the transaction. The appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives.

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Please note that there is currently no standard definition of green bond. Without limiting any of the statements contained herein, Morgan Stanley makes no representation or warranty as to whether a bond constitutes a green bond or conforms to investor expectations or objectives for investing in green bonds. For information on characteristics of the bond, use of proceeds, a description of applicable project(s), and/or any other relevant information about the bond, please reference the offering documents for the bond.

Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally, the longer a bond's maturity, the more sensitive it is to this risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer.

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Foreign fixed income securities may involve greater risks than those issued by U.S. companies or the U.S. government. Economic, political and other events unique to a country or region will affect those markets and their issues, but may not affect the U.S. market or similar U.S. issuers.

The returns on a portfolio consisting primarily of Environmental, Social and Governance (“ESG”) aware investments may be lower or higher than a portfolio that is more diversified or where decisions are based solely on investment considerations. Because ESG criteria exclude some investments, investors may not be able to take advantage of the same opportunities or market trends as investors that do not use such criteria.

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